“There is a good chance that inflation will reach 5% later this year and it is more likely than not to remain above the 2% target throughout 2012, boosted by the increase in VAT, higher energy and import prices, and some rebuilding of companies’ margins.”The April 2011 Bank of England Inflation Report

In a prior blog I reviewed the main drivers behind the current run-up in the rate of inflation. The current rise in the rate of inflation has been attributed to the surge in commodity prices, energy prices and an increase in VAT. April 12 2011 CPI release reported an unexpected slow down in the growth of the annual rate inflation to 4.05% from 4.4%.

Chart.1 Inflation Growth Slows Chart.1 Inflation Growth Slows

In addition, the CPI constant taxes measure also lost momentum from an annual rate of 2.7% to 2.4%. According to ONS, the main drivers behind the pull back in inflation rate were food and non-alcoholic beverages, recreation and culture, and air transport.

Chart.3 Contribution to Monthly Change in CPI All Items Index

Inflation rose by 0.3% between February and March 2011, compared to 0.6% last year and 0.7% the prior month. Chart.2 highlights that the heaviest negative contribution to the monthly change in CPI was by food and non-alcoholic beverages. The ONS reports that:” the downward effects were widespread with the most significant coming from fruit, and bread and cereals. Fruit prices, overall, fell by 4.7 per cent, a record for a February to March period. Bread and cereal prices, overall, fell by 2.6 per cent, the largest ever monthly fall.”(ONS CPI report March 2011).

Significant upward contribution came from transport costs that rose by 1.2% in March. “The largest upward effects came from fuels and lubricants where pump prices rose by 2.7 per cent to reach record levels of £1.32 for petrol and £1.38 for diesel. There were also upward effects from air transport and the purchase of second-hand cars furniture, household equipment and maintenance: the largest upward effect came from furniture and furnishings where prices rose by 3.7 per cent”. (ONS CPI report March 2011).

Chart.4Contribution to Annual Change in CPI All Items Index

Chart.3 depicts the percentage contribution of CPI constituent annual change in CPI. All CPI constituents contributed positively to the recent rise in annual inflation rate. The largest contributor to both monthly and annual inflation rates was transportation costs. The contribution from food & non-alcoholic beverages declined from 0.69 in Feb to 0.49 in March.

Summary

Oil and energy prices continue to exert heavy upward pressure on the rate of inflation as evidenced by contributions of transport costs, housing and household services. The recent slow down in the rate of inflation does provide a boost to the doves in the monetary policy committee of the Bank of England.

However according to the BOE:“there is a good chance that inflation will reach 5% later this year and it is more likely than not to remain above the 2% target throughout 2012, boosted by the increase in VAT, higher energy and import prices, and some rebuilding of companies’ margins.”The April 2011 Bank of England Inflation Report

The May 17 report should shed some slight on the direction of trend in the rate of inflation.